Summary
August was tale of two halves:
Market
The month started on a positive note with RBI increasing the policy repo rate by 25bps to 6.5%, which was expected. The RBI also maintained a “Neutral” policy level which was well received. This signal of a prolonged pause in policy rate and the expansion in real policy rates to RBI’s desired level of 150-175 bps, led to a rally in yields, approaching the lows of the month.
This stance was further validated by July’s inflation readings, with better than expected moderation. The Consumer price index (CPI) dropped to 4.2% versus a consensus of 4.5% and was also down from 4.9% in the prior month. This drop was led by broad-based easing in food price and core inflation.
FY19’s first quarter GDP data also surprised positively, by accelerating to 8.2%, versus 7.7% in 4QFY18. Real gross value added (GVA) picked up to 8% from 7.6% growth in 4QFY18, largely led by the agriculture and industrial sectors. On the demand side, private consumption surged by 8.6% while fixed capital formation (GFCF) grew at 10%.
However, the external headwinds turned out to be a bigger influence, despite the improving bottom up growth inflation dynamics. The EM contagion risk dragged down the INR by 3.3% in August. This was exacerbated by a sharp 10.4% rise in dated Brent crude prices, after softening by 4.1% in first half of the month. Should these trends persist in near term, these factors might feed into pressure on 2 fronts.
Performance
Despite an 18bps rise in yields on the benchmark ten-year Government of India bond in August. This was however offset by a 9bps contraction in spreads on (AAA)-rated ten year corporates. That net spread move combined with the beneficial impact of high income coupons drove a modest 0.06% gain in the Fund’s net asset value (NAV) in INR terms.
However, the currency depreciated sharply, by 3.30% against US dollar this month, dragging the NAV to a loss of 3.2% in USD terms. Year to date the Fund’s NAV is up 1.28% in INR; but down 8.9% in US dollar terms, dragged down by a 10% rupee-dollar depreciation.
Strategy
The Fund had prudently reduced its duration risk earlier in the year. We have decided to stick to the strategy of prudence given the uncertainty in oil markets, the risk of escalation of the trade (and currency) wars and political uncertainty ahead of next year’s general elections in India. The weakness in the INR-USD is, in our opinion, meaningfully overdone, and we expect a rebound, but the timing will be dependent on the resolution of some of these macro issues impacting EM.
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